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Why Mutual Fund Fees Seem to Be Dropping (but Aren't)

NEW YORK (TheStreet) -- Good news: Mutual fund investors paid less in fees last year than anytime before, and the savings could continue this year.

Now for the caveat: The fund companies don't get the credit. That goes to investors who have embraced the low-fee gospel, and to last year's soaring stock market.

An assessment from Morningstar, the market-data firm, shows the average investor paid 0.71% in expense ratio last year, down from 0.72% in 2012. While that's not a huge drop, it marks a low point in a steady decline from 0.93% in 1990.

Put another way, for every $100 held in mutual funds, the average investor paid 71 cents in fees last year. It doesn't sound like much, but if the fund earned nothing over 20 years, fees would reduce the $100 to just under $87.

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This cost is just as damaging when the fund gains value, but the damage is not as obvious. The larger the fee is, the more harm it does. Over a 50- or 60-year investing career of a 30-year-old who lives to 80 or 90, the drag from fees really adds up.

In calculating fees paid by the average investor, Morningstar adjusts for the size of each fund so one with billions in assets under management has more effect on the average than one with mere millions. The result is a "weighted average."

Morningstar also calculated the "simple average" charged by each fund -- the average of all funds' fees regardless of fund size. Last year it was 1.25%, down from 1.28% in 2012.

The slight drop in fees paid and fees charged were, for the most part, caused by the soaring stock market, Morningstar says. Fund managers' contracts typically reduce their fee charges as the assets under management grow. Because of a lag in the way this is calculated, the stock-market's gains at the end of the year will cause lower fee charges this year -- unless the market takes a dive.

Why is the average paid by investors so much smaller than the average charged by the firms? Because investors as a whole tend to favor funds that charge less. Many index-style funds, which just track market averages such as the Standard & Poor's 500, charge only 0.2% or less, because they don't have to pay a team of money managers.

Morningstar says that last year 95% of new money invested went into the 20% of funds with the lowest fees. That figure averaged 56% in the 1990s, before index funds attained the widespread popularity they have today.

"Low costs generally lead to superior returns, so no doubt some of the money going into low-cost funds also reflects investors following performance as well as expenses," Morningstar said.

Among the interesting tidbits in the data: While the average paid by investors has moved steadily down since 1990, the average charged has followed a different path. In 1990 it was 1.28%, the same as in 2012. It was as high as 1.47% in 2003.

What does this mean? It underscores the fact that most mutual fund firms are for-profit corporations with a financial incentive to keep fees high. The decline in fees investors actually pay shows they have come to realize that a fund that charges high fees does not necessarily provide bigger returns. In fact, the opposite is true. Despite all their efforts to find hot stocks and bonds, the typical fund manager can't find enough of them to offset the drag from high fees.

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